Could the next U.S. President face a recession?

Politics and economics are closely intertwined and lately their relationship seems to be growing all the more complex. With the approaching election and uncertainties surrounding Brexit, investors around the world are getting anxious about what’s in store for the U.S. economy.

The yield curve – the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill – has outperformed other indicators as a reliable predictor of recessions two to six quarters ahead.[1] Right now, the spread predicts an 8 percent probability of a U.S. recession in June 2017.[2]

Since 1978 – and based on data going back to 1916 – the state of the U.S. economy can be one deciding factor for which party is voted into power during an election year, according to a study by Yale University economics professor Ray C. Fair. If the economy is in good shape during the first three quarters of the election year, particularly GDP growth, the incumbent party candidate has a higher chance of winning.[1]

How has U.S. GDP been doing? Unfortunately, it’s been on a downward trend since Q2 2015. Fourth-quarter 2015 ended the year at 1.4 percent and the latest revised estimate for Q1 2016 by the Bureau of Economic Analysis (BEA) came in at only 1.1 percent.[2]

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Real GDP growth has been on a downward trend over the last four quarters. Corporate profits have also decreased 4.3 percent over the last 4 quarters. Source: BEA

Second quarter GDP, estimated to come in higher at around 2.4 percent, is expected to be reported this month. Some analysts predict growth in 2016’s second half of could range between 2 and 2.5 percent. For the year, U.S. GDP estimates are about 1.8 percent, a decline from 2.4 percent in 2015.[3]

As for the 2017 economic forecast, it will largely depend on how Brexit continues to unfold, who sits in the White House, consumer confidence levels, and changes to monetary and fiscal policy. Some estimate next year could fare slightly better at around 2 percent, but those projections are likely to change as new information becomes available in the coming months.[4]

Ripe for a recession in the next few years?A June Wall Street Journal survey of more than 60 economists shows that the odds of a recession within the next 12 months is about 21 percent, a rise of two percentage points higher than the poll taken in April.[5]

The month of May caused many to worry about growth grinding to a halt as 11,000 jobs were create making for an unusually low number compared to typical monthly gains of 200,000 jobs. Those fears were largely quelled recently when June’s data was released and U.S. job creation gained strength becoming the best month of the year, with 287,000 new jobs created.[6]

Economic concerns with a Trump presidencyOne thing is for sure – whoever ends up getting elected in November will have a lot of Americans depending on him or her to hit the ground running. The list of to-dos is long: create new jobs, raise consumer confidence and strengthen the U.S. economy in addition to fighting terrorism, immigration reform, dealing with civil unrest and passing new bills including tax code changes.

De facto GOP nominee Donald Trump has certainly been hit with a lot of criticism lately about his ability to effectively manage the U.S. economy. His rival Hillary Clinton recently said, “Trump would throw us back into recession” and she isn’t the only one who feels this way. [7]

A recent Moody’s Analytics report caused quite a stir when it said Trump’s stance on taxes, government spending, immigration and international trade would result in a two-year-long recession starting in 2018, with higher interest rates, lower stock prices, reduced property values, higher trade deficits and an economy that is “more isolated and diminished.”

Moody’s estimates that Trump’s proposed tax code overhaul for both individuals and corporations would result in a flatter system with lower marginal rates, scaled back deductions and about $9.5 trillion in tax cuts over the next decade. The report claims these large scale changes would bring revenue as a percentage of GDP to its lowest since World War II.[8]

The report also predicts that Trump’s proposed policies would result in rising unemployment rates – as high as 7 percent versus below 5 percent today – and about 3.5 million fewer jobs.

Critics, such as UC-Irvine economics professor Peter Novarro disagree with the claims that Trump would cause a recession. Novarro argues, “Moody’s Keynesian and partisan analysis also deeply discounts the supply side stimulus effects associated with the tax cuts themselves.”[9]

Economic concerns with a Clinton presidencyWhat’s being said about the economic results that a Clinton Administration might unleash? The Tax Foundation performed a detailed analysis of the potential impacts on U.S. GDP, revenue and after-tax income from Clinton’s proposals to increase marginal tax rates and enforce a 30 percent minimum tax, known as the Buffett Rule, on taxpayers with incomes of $5 million or greater.

Their findings estimate that a Clinton presidency would reduce GDP by 1 percent over the long-term, reduce revenue on a static and dynamic basis and cause a 0.7 percent drop in after-tax income for the top 10 percent of taxpayers and at least a 0.9 percent drop for all tax payers when accounting for reduced GDP.[10]

The study also predicts that Clinton’s tax policies would lead to a decrease in wages by 0.8 percent, a pullback in capital investment of 2.8 percent and roughly 311,000 fewer full-time jobs. This would reduce payroll tax revenue by about $80 billion over the next ten years.[11]

Many also expect Clinton to carry on President Obama’s policies. During his two terms, Obama has helped halve the unemployment rate, increase hourly wages and strengthened the stock market.

Under Obama’s presidency, we’ve seen higher education costs, a tight credit market, the widening gap between affordable home prices and incomes, and more unemployed Americans who haven’t been able to find jobs, as total U.S. household debt have risen, home ownership has declined, and lower labor participation rates have dropped about three percent.[12]

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Student loan debt has risen by about half a trillion dollars under the Obama administration. Source: Fortune

Timing the next recession
Regardless of which candidate takes office, many economists believe the U.S. is overdue for a recession. So the question is not whether the U.S. will undergo a recession, but when.

The National Bureau of Economic Research reports that the average expansion cycle after World War II lasts less than five years, and the economy has been growing for the last seven. “I think the end of 2017 or the start of 2018 is quite possible for a recession. All the indicators seem to be lining up for that time frame,” Brad McMillan, CIO of Commonwealth Financial, told CNN Money. [13]

If a recession does occur in the next few years, it’s unlikely to be as destructive as the financial crisis. Even if businesses and consumers don’t have the cash or confidence to increase their spending, the government could step in to help boost jobs and get the economy moving again.

Thus, many economists and business leaders are supportive of the infrastructure spending initiatives Clinton has proposed if elected. Clinton is requesting the government to spend at least $275 billion to repair and build new bridges and roads, broaden public transit systems and provide more Americans with broadband internet access.[14]

What do you think is in store for the election and the U.S. economy?

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